Michael Pettis: The Global Trade Reset Is Inevitable

Name: Michael Pettis: The Global Trade Reset Is Inevitable
Uploaded: 2025-12-01T17:04:55.000Z
Duration: 2 h 36 min 40 s

Understanding Global Economic Imbalances

The Nature of U.S. and China's Economic Debt

The U.S. did not consciously decide to abandon manufacturing; rather, it reflects broader economic trends and decisions made by other countries.

The U.S. has high debt levels supporting consumption, while China’s debt supports production, leading both nations into unsustainable debt situations.

Inevitable Trade Adjustments

There is an inevitable adjustment occurring between countries that manage their external accounts effectively and those that do not, often referred to as a trade war or contraction.

Insights on Globalization Issues

Michael Pettis discusses the long-standing issues with globalization, emphasizing the neglect of political and institutional aspects in economics since the 1970s and 80s.

He highlights that internal imbalances within a country must align with its external imbalances, suggesting a direct relationship between domestic policies and international economic conditions.

Interconnected Economies

External imbalances are interlinked; one country's surplus necessitates another's deficit, creating complex dependencies among nations' economies.

American economists often struggle to grasp this interconnectedness due to a perception that only U.S. actions drive global economic dynamics.

China's Trade Surplus Dynamics

China’s significant trade surplus is not merely a response to U.S. savings rates but results from domestic policies leading to excess savings which are then invested abroad for stability and security reasons.

Investment patterns show that countries with excess savings tend to invest in stable economies like the U.S., driven by safety rather than reflecting weaknesses in those economies themselves.

Manufacturing Decisions Rooted in Policy Choices

The decline of manufacturing in traditional deficit countries (like the U.S.) was influenced by other nations’ decisions to expand their manufacturing capabilities rather than a conscious choice by Americans themselves.

Economic Imbalances and Trade Dynamics

The Unsustainable Nature of Trade Deficits

Joan Robinson's insights from the 1930s highlight that persistent trade deficits are unsustainable, leading to inevitable adjustments such as trade wars and contractions.

Current Global Economic Adjustments

The ongoing global economic situation reflects an adjustment towards imbalances between countries with control over their external accounts (e.g., China) and those with less control.

China's Role in Global Savings and Investment

China is identified as a primary country controlling its external accounts, characterized by high savings which it either exports or invests.

Understanding Excess Savings

Excess savings in China refers to savings exceeding investments; despite high investment levels, consumption remains low, necessitating trade surpluses to avoid unemployment.

Historical Context of Trade Surpluses

The phenomenon of trade surpluses is not unique to China; historically, countries like Germany and Japan have also run significant surpluses, impacting domestic economic control.

Challenges in Increasing Consumption Share

Efforts for China to increase its consumption share of GDP face historical challenges similar to those experienced by the U.S. during the Great Depression and Japan's stagnation in the 1980s.

Structural Issues Affecting Consumption

Low household income as a percentage of GDP leads to low consumption rates; competitive manufacturing sectors thrive under these conditions but hinder domestic consumption growth.

Policy Implications for Economic Adjustment

To raise consumption share effectively, policies must shift income from businesses to households; however, this risks reducing business competitiveness globally.

Consequences of High Investment Without Productivity

High investment levels can lead to economic activity without wealth generation if investments do not meet actual needs; this has been observed historically in various economies.

The Impact of Investment Shifts in China

The Dangers of Nonproductive Investment

High saving and investment growth models can lead to wealth destruction, ultimately worsening economic conditions until debt halts progress.

Transition from Real Estate to Industrial Sector

A significant transfer of loans from the real estate sector to the industrial sector has occurred, highlighting underlying economic issues in China.

Debt and GDP Dynamics

Historically, China's debt funded productive investments; however, post-2008, debt began rising faster than GDP despite high investment levels.

Global Crisis Response

The global financial crisis severely impacted China's current account surplus, which dropped from over 10% to 3% of GDP within a few years.

Infrastructure Investment Surge

In response to the crisis, Beijing initiated a massive increase in infrastructure investment rather than addressing existing oversupply issues.

Shift in Investment Focus

By 2015, as economic troubles resurfaced, Beijing shifted focus from infrastructure to property investments by easing mortgage rates and purchase restrictions.

Consequences of Property Boom Collapse

The property boom led to an unsustainable bubble that burst by 2022, resulting in a sharp decline in property investment and subsequent risks for GDP growth.

Manufacturing Investment Increase

As property investment declined sharply, manufacturing investments surged dollar-for-dollar to prevent overall investment drop-off without addressing actual demand needs.

Overcapacity Issues

Excessive manufacturing capacity led to involution where supply outstripped demand. Businesses faced pressure to sell at cut-rate prices due to inventory financing challenges.

Economic Shifts and Investment Strategies

Addressing Overproduction in Involuted Sectors

The need to reverse excess production in involuted sectors is emphasized, with a noted reduction in investment capacity leading to observable changes in inflation and industrial output data.

Investment Dynamics and GDP Growth

Reducing investment in involuted sectors risks reverting to 2022 levels of declining investment, which could hinder GDP growth. A shift of investments is anticipated towards infrastructure.

Infrastructure Spending Trends

An increase in infrastructure spending is expected, alongside investments into non-involuted manufacturing sectors such as petrochemicals, steel, and automobiles. This reflects government efforts to stabilize ten key industries.

Global Implications of Excess Supply

The strategy of reallocating investment from real estate to manufacturing (e.g., electric vehicles) may be effective for China but poses challenges due to existing excess supply that necessitates exports.

Impact on Global Trade Dynamics

Countries like Germany face significant issues due to shifts in automobile supply chains influenced by China's export strategies. Developing countries with automotive sectors are particularly vulnerable.

Trade Imbalances and Economic Consequences

Current State of Global Trade Balances

There has been no substantial adjustment regarding the trade surplus between China and the US; both nations continue experiencing growing trade deficits/surpluses respectively.

Misinterpretation of Bilateral Trade Data

While some argue that the US-China trade deficit has contracted, it remains largely irrelevant as systemic trade imbalances persist. The focus should be on overall global trade dynamics rather than bilateral figures.

Income Generation Through Imports

Increased imports from countries like Peru generate income that leads to further consumption patterns, including purchasing Chinese goods. This cycle perpetuates the US's growing trade deficit.

Potential Changes in Trade Deficits

A recent contraction in the US trade deficit could signal a potential shift; however, sustained reductions are necessary for re-industrialization efforts and meaningful changes within global trading systems.

Future Scenarios for Surplus Countries

If major economies reduce their deficits (like the US), surplus countries (e.g., China, South Korea) may have to adjust their surpluses accordingly. This could lead to significant economic repercussions globally.

Global Economic Rebalancing and the Role of Tariffs

The European Context

There is a growing sense of panic in Europe regarding economic stability, as it struggles to keep pace with strategies employed by China and the US to control external accounts.

The discussion raises questions about the role tariffs should play in addressing trade deficits, particularly emphasizing that the US has an excessive trade deficit.

Understanding Tariffs as a Policy Tool

Tariffs are described as a policy tool that can either be contractionary or expansionary, depending on their implementation and context.

A historical perspective is provided where tariffs were used similarly to currency depreciation; both methods aim to tax imports while subsidizing exports.

Mechanism of Tariffs

When tariffs are applied correctly, they can benefit manufacturing sectors at the expense of household income. This dynamic suggests that households are net importers while manufacturers are net exporters.

The ideal tariff structure would be straightforward (e.g., a flat 30% tariff), but current practices involve complex bilateral and sectoral tariffs that complicate economic outcomes.

Proposed Solutions for Trade Imbalances

To resolve trade imbalances effectively, suggestions include forming a customs union where countries cannot run systemic imbalances without penalties for persistent surpluses.

Another proposed method involves restricting capital inflows since running a trade surplus necessitates exporting excess savings, which leads to corresponding deficits elsewhere.

Capital Flow Taxation and Political Challenges

A taxation approach on foreign capital exports into the US is suggested as an effective measure; this idea aligns with economist J. John Hansen's concept of a market access charge.

Despite initial discussions around taxing capital inflows during the Trump administration, such measures have faced significant political resistance from Wall Street and other stakeholders concerned about free capital movement.

Trade Imbalances and Globalization: Analyzing Bilateral Tariffs

The Role of Bilateral Tariffs

Discussion on whether bilateral tariffs can reduce trade imbalances between China and the US, suggesting that while they generate taxable income for the US, their impact on trade balances is minimal.

Assertion that bilateral tariffs theoretically do not work; historical context provided by a mentor who emphasized systemic rather than bilateral imbalances.

Acknowledgment that if all countries imposed tariffs on one nation (e.g., China), it could have an effect, but this scenario is unlikely.

Current Trade Policies and Their Effects

Examination of current tariff rates on China, noting fluctuations from high rates to as low as 10%, questioning the expected discouragement of trade due to these tariffs.

Insight into profit margins in Chinese manufacturing, suggesting that a 10% tariff should significantly affect trade flows but does not appear to be doing so.

Currency Adjustments and Economic Behavior

Explanation of how currency adjustments can negate the effects of tariffs; specifically mentioning the weakening of the Chinese currency in real terms.

Discussion about investment in China focusing more on maintaining employment rather than profitability, leading to negative profit margins for many companies.

Implications for Future Globalization

Transitioning from past globalization issues to potential new forms; questioning whether current conflicts will lead to a restructured global trading environment or further deglobalization.

Reference to economists from the 1930s predicting consequences of persistent trade surpluses and deficits, emphasizing the need for balance in international trade systems.

Options for Future Trade Systems

Presentation of two possible futures: restructuring towards balanced free trade or moving towards deglobalization where deficit countries withdraw from global systems.

Emphasis on mutual withdrawal implications—if deficit countries exit, surplus countries must also reconsider their positions within global trade dynamics.

Political Feasibility of New Globalization Models

Inquiry into whether intelligent globalization through regulatory frameworks is politically feasible; critique of existing institutions like the IMF regarding their effectiveness in managing imbalances.

Global Trade Imbalances and Economic Policies

The Challenge of Global Governance

Discussion on the limitations of global governance, particularly the UN's inability to resolve political power disparities among nations.

Two potential paths for addressing global trade imbalances: restructuring the trading system or allowing countries like China and South Korea to expand their manufacturing shares.

The Role of the United States in Global Trade

Assertion that Trump's policies are a reflection of pre-existing issues in trade deficits, indicating a lack of effective policy implementation.

Emphasis on how advanced economies (US, UK, Canada) absorb most global imbalances while developing countries should ideally run small deficits.

Consequences of Trade Deficits

Warning that if major economies like the US stop running deficits, it could lead to a collapse in the current global trade system.

Explanation that more than half of global surpluses would need to disappear if major deficit countries cease their roles.

Manufacturing and Economic Health

Observation that persistent trade surpluses correlate with high manufacturing shares in GDP across various countries.

Analysis showing that surplus countries often subsidize manufacturing at the expense of household income, leading to economic imbalances.

Reviving Manufacturing in Advanced Economies

Discussion on how open economies must adapt to external pressures from subsidized manufacturing abroad while trying to revive their own industries.

Question raised about the seriousness of US efforts towards re-industrialization amidst competition from heavily subsidized foreign manufacturers.

China's Consumption Trends

Inquiry into China's consumption as a percentage of GDP, noting its historical lows and recent fluctuations over decades.

Highlighting China's need for significant increases in consumption share (10–15 percentage points), which remains one of the lowest globally despite slight improvements since 2011.

Economic Challenges in China

Consumption vs. GDP Growth

To achieve sustainable economic growth, consumption must outpace GDP growth by at least 1.9 percentage points; however, China struggles to increase consumption at this rate.

The idea of increasing consumer debt as a solution is discussed, comparing it to the high levels of consumer debt seen in the US over the past 30 years.

The focus should be on resource production rather than merely increasing money supply; without increased production, transferring resources from businesses could destabilize the economy.

Manufacturing Competitiveness

Chinese manufacturing competitiveness is questioned; while competitive, many firms rely on substantial subsidies rather than efficiency.

A hypothetical scenario illustrates how unlimited funding and low-interest rates can make even inexperienced manufacturers competitive in sectors like electric vehicles (EV).

Economic Implications of Subsidy Reversal

If subsidies are reduced or reversed, many Chinese companies may struggle to maintain their competitiveness due to reliance on these financial supports.

Manufacturing constitutes a significant portion of China's GDP (28%), and undermining this sector could lead to severe economic repercussions.

Historical Context: Japan's Experience

Japan's historical context is referenced; its manufacturing sector also faced decline alongside stagnant consumption growth from 1991 to 2008.

Similarities between Japan's experience with subsidies and China's current situation suggest that reversing support could lead to decreased global competitiveness and economic contraction.

Household Income Dynamics

The primary issue isn't just low consumption relative to household income but that households retain an exceptionally small share of GDP compared to other economies.

Employment instability and declining wages have led consumers to reduce spending during tough economic times, exacerbating the problem of low household income share.

Debt Surge and Economic Resilience

Despite challenges such as deflation and a real estate bubble burst, China continues progressing due to rising debt levels and sustained investment strategies.

A comparison with potential US responses highlights that maintaining production despite lackluster demand can prevent recession but raises questions about long-term sustainability.

Economic Adjustments and Global Trade Dynamics

Historical Context of Economic Adjustments

The speaker discusses the concept of "debt capacity" and how it leads to significant economic adjustments when exhausted, likening it to building "bridges to nowhere."

The U.S. in the 1920s is presented as an example of a high-saving, low-demand economy that adjusted through severe contractions in consumption (15-20%) and production (35%).

In contrast, Japan's adjustment post-1991 involved sustaining consumption growth while experiencing zero GDP growth, leading to a prolonged economic malaise.

The speaker notes that while the U.S. maintained its global GDP share, Japan's share significantly declined from 17% to around 5-6%.

A theoretical third adjustment method is proposed: increasing consumption without slowing GDP growth, though historically challenging to achieve.

Current Economic Trends and Sectoral Shifts

Discussion on China's credit transfer from sectors with excess capacity (like steel) to emerging industries such as petrochemicals raises concerns about merely postponing necessary adjustments.

The speaker emphasizes that additional investments should be less damaging; producing more steel may be preferable over oversaturating markets with solar panels.

Future Predictions for Global Trade

Speculation arises regarding trade's decline as a percentage of GDP due to geopolitical factors rather than pure economic shifts.

The speaker anticipates worsening conditions before improvement but acknowledges the unpredictability of political influences on trade dynamics.

Historical Parallels and Adjustment Processes

Comparisons are drawn between current times and historical periods like the 1970s or 1930s, highlighting challenges faced by democracies during significant transitions.

Emphasis on the difficulty of making accurate predictions about future global conditions due to historical patterns where most forecasts tend to be incorrect.

Potential Policy Directions for China

If Chinese leadership aimed at boosting consumption at all costs, they might focus on technological breakthroughs that could enhance productivity directed towards workers' benefits rather than profits.

Technological Breakthroughs and Local Government Assets in China

The Need for Technological Innovation

A significant technological breakthrough is essential for economic progress, as mere numbers alone won't suffice.

Local governments in China possess substantial assets, exemplified by Guay Joe owning the world's most valuable liquor company, Ma Thai.

Utilizing Local Assets for Economic Growth

A proposal suggests that provinces create holding companies to manage state-owned enterprise (SOE) assets and distribute shares to residents, enriching households.

This approach would require a fundamental change in local government structures, which could be challenging but potentially beneficial.

Challenges of Institutional Change

Implementing these changes is complex; there are no straightforward solutions. Inaction may lead to disruptive adjustments later.

AI Investment and Its Impact on Economic Imbalances

AI Investments in the US vs. China

The U.S. invests over 1% of GDP annually into data centers for AI development, while China's focus is on efficiency rather than sheer investment volume.

Productivity Growth vs. Employment Reality

While high technology investments can boost productivity growth globally, they may not significantly address existing economic imbalances or employment issues.

Understanding Deflation in China

Nature of Current Deflationary Trends

Deflation can be positive if income grows alongside falling prices; however, current deflation results from excess production without corresponding demand.

Domestic Demand Weakness

Prices are declining due to weak domestic demand; many producers are now focusing on exports as local sales become unprofitable.

Consumer Lending and Economic Stimulation

Increasing Consumer Lending Pressure

Beijing has urged banks to boost consumer lending amid economic uncertainty; however, many consumers prefer debt repayment over new borrowing.

Risks of Increased Lending Standards

While increasing consumer lending is feasible by lowering standards, it risks rising non-performing loans within the banking system.

Economic Insights on Debt and Investment in China

The Impact of Lending Standards

Lowering lending standards is a common strategy to increase consumption across different countries, including China, the US, and Spain. However, this approach may lead to future economic problems.

Recent enforcement of laws regarding interest rates has clarified the gray area between 24% and 36%, which could impact borrowing practices.

Concerns Over High-Interest Borrowing

Borrowing at high-interest rates (above 24%) is viewed as non-productive or "Ponzi borrowing," which can harm economic stability.

Chinese Equity Market Dynamics

The low participation of Chinese citizens in the equity market contrasts with the US stock culture where retail and institutional investors are heavily involved.

Many Chinese prefer real estate investments over equities due to historical volatility in the stock market.

Investor Behavior and Market Sentiment

Historical trends show that sophisticated investors often sell early while less experienced investors buy late, leading to significant income transfers during market fluctuations.

Despite recent positive performance from banks due to dividends, there remains a general nervousness among Chinese investors about entering the stock market.

Corporate Finance Structure in China

In contrast to the US's balanced corporate finance structure (one-third equity, bonds, bank loans), over 90% of corporate financing in China comes from bank loans, indicating a smaller equity market impact.

Medium-Term Economic Outlook for China

Current expectations suggest that China's growth may be lower than previously anticipated; estimates have shifted from around 5% down to approximately 4.5%.

Debt Capacity Considerations

China's debt capacity allows for achieving growth targets through potentially unproductive investments; however, higher targets could lead to rapid debt accumulation.

Risks Associated with Debt Growth

China's overall debt-to-GDP ratio exceeds that of the US and is growing rapidly. This poses risks as reaching debt capacity limits could necessitate difficult adjustments.

Historical Context of Debt Crises

Past examples like Japan post-1991 highlight that domestic debt crises can occur without external debts. Misallocated investments often trigger these crises rather than outright defaults.

Understanding Debt Capacity Limits

Running out of debt capacity does not equate to default but indicates misallocation issues requiring significant financial adjustments when limits are reached.

Implications for Future Policy Decisions

It’s crucial for policymakers to manage debt levels proactively before reaching critical limits similar to past economic downturn scenarios faced by Brazil in the 1980s.

This structured summary encapsulates key discussions surrounding China's economic landscape concerning lending practices, investment behaviors, corporate finance structures, and potential risks associated with rising debt levels.

Understanding Debt and Economic Imbalances

The Impact of Debt on the Economy

High debt servicing costs can undermine economic stability. Borrowing $100 to invest in assets worth only $80 leads to a decline in wealth over time.

As long as one can maintain the illusion of asset value, they may not feel poor; however, significant gaps between actual and perceived value necessitate large transfers to service debt, which ultimately harms the economy.

Many economists mistakenly believe that guaranteeing no defaults allows for infinite debt capacity, ignoring the reality that excessive borrowing does not equate to wealth creation.

Tariffs and Trade Imbalances

Current tariffs are ineffective at resolving trade imbalances between the US and other countries; they merely shift trade flows without addressing underlying issues.

An example illustrates that depreciating currency against one nation while maintaining it against another does not stop investment flows but redirects them instead.

Foreign Investment and Domestic Demand

Announced foreign investments into the US will not improve manufacturing or address trade imbalances because domestic demand is too weak to justify new investments.

American businesses have access to capital but lack good investment opportunities due to insufficient domestic demand; thus, foreign investment is unlikely to stimulate growth meaningfully.

The Nature of Debt in China vs. the US

In contrast with the US needing rising debt for consumption support, China requires increasing debt for production support due to its growing trade surplus.

Both nations face unsustainable debt levels: the US relies on consumer spending while China depends on production-driven growth.

Conclusion and Final Thoughts

The current economic system is unsustainable for both countries; reform is necessary for mutual benefit.

Monetary Matters Podcast Summary

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